When and how to refinance a personal loan

Refinancing a personal loan  lets you replace your existing loan with a new loan — potentially with a lower interest rate and smaller monthly payment.

Deciding to refinance a personal loan might be a good option if your credit score has recently improved, which can help you score a more competitive interest rate. You can also choose to extend your repayment term, although this may mean paying more overall.

Ultimately, the right decision depends on your financial situation. If you are able to qualify for better terms, then it may be a good idea to refinance. If you aren’t, there are alternatives to personal loans that you can consider.

What does it mean to refinance a personal loan?

When refinancing a personal loan, you’ll apply for a new loan — usually with a different lender — and then use the funds you receive to pay off your old loan. Once the process is complete, you’ll make payments on your new loan.

You might want to refinance a loan for any number of reasons, but ideally, it would be to obtain a new, better interest rate as part of the process. In some cases, you may also choose to refinance in order to borrow more money for a new expense or financial need.

How to refinance a personal loan

When you refinance a personal loan, you should know how much you need and check your credit score before comparing lenders. After you know where you want to apply, the application process is similar to taking out a regular personal loan.

1. Figure out how much money you need

Before you shop for quotes, determine the exact amount of money you need to pay off your current loan. Your payoff amount is important because it will help you choose a lender that offers competitive terms for refinancing.

You should also check if your original lender charges prepayment penalties. These can add up quickly, and they might outweigh the benefits of refinancing.

Take action: Log in to your account online or call your lender to check your outstanding balance, payoff quote and prepayment fees.

2. Check your credit score and credit report

You will also need to check your credit score and credit report before you refinance. This is a necessary step to gauge if you qualify for a lower rate than what you’re currently paying. If the new interest rate isn’t significantly lower, it may not be worth it to refinance.

You can also request a free weekly credit report from each of the three credit bureaus — Equifax, Experian and TransUnion.

As you’re shopping around for a new loan, determine whether lenders do a soft or hard pull of your credit score when giving you a quote. Many lenders offer a prequalification process, which allows you to check your rates without affecting your credit score.

A hard credit score will negatively affect your score, at least in the short term, so you’ll want to get quotes from lenders that show you your rates using only a soft pull.

Take action: Request a free credit report through Equifax, Experian or TransUnion.

3. Compare rates and terms

Research is key when you refinance a personal loan. Before refinancing, compare rates and terms from multiple lenders to ensure you get the best deal for your financial situation.

Compare fees, such as origination fees, which can increase your annual percentage rate (APR). The amount you can borrow and loan terms will also factor into your decision. You should choose a lender that offers the amount you need to refinance.

If you’re looking to lower your monthly payments, carefully consider if you should extend your loan term. Even if you get a lower APR, you could end up paying more in interest over a longer repayment period.

Take action: Compare the features of at least three personal loan refinance offers. To see the overall costs of each loan, try using a personal loan calculator.

4. Speak with your current lender

Don’t overlook your current lender during the research process. It may be willing to offer you a better deal — although it’s rare to be able to refinance with your current lender.

Because you already have an existing relationship with your current lender, it may be easier to find out whether you can qualify for a second personal loan, which may not require a new credit inquiry.

Take action: Contact your existing lender to ask if it is willing to refinance your loan or revise your current rate and terms.

5. Apply for the loan

When you’ve settled on a lender with good options, submit your application and provide any required documents. This could include your Social Security number, paystubs, bank statements or tax documents.

Prequalification is an important step, but it isn’t a formal application. To move forward with the process, you will need to submit a full application — and undergo a hard credit check — to confirm that you qualify.

Take action: Read through the fine print of the loan before accepting it. Take note of your payment schedule and any fees, including prepayment penalties. If you’re satisfied with the terms of the loan, you can accept it and will typically receive funds within a few days.

6. Start making payments on your new loan

Once you receive funds from your new loan, you’ll use them to pay off your existing loan. This should be done as soon as possible to avoid accruing unnecessary interest or making double loan payments.

Receiving your loan funds also enters you into the repayment period of your new loan. The exact dates — and terms — depend on your loan contract. And just like with your old loan, on-time payments keep your account in good standing.

Take action: Set up autopay for your new refinance loan so you never miss a payment.

When to refinance a personal loan

Refinancing your loan almost always makes sense if it will save you money.

“For example, if interest rates drop and you are able to get a lower interest rate, you would want to consider refinancing,” says Adam Marlowe, chief strategy officer for Georgia United Credit Union.

Other times it may make sense to refinance your personal loan include:

• You have a better credit score: One of the best ways to qualify for a lower interest rate on a personal loan is by improving your credit score. If your score has increased since you initially took out your loan, this could be a good reason to refinance.
• Your income decreased: If you have lost your job or have reduced income, you can refinance your current loan for a longer repayment term, which may not save you money in the long run but could help reduce your monthly payment.
• You’d like to pay your loan off faster: If you can afford larger monthly payments, you may want to refinance into a shorter loan term. Paying your loan off in a shorter amount of time will save you money in interest overall.
• You can afford the fees: Refinancing may incur fees, such as origination fees or application fees. Your current lender may also charge a prepayment fee if you pay your loan off before the repayment period ends. Before applying for a refinance loan, ensure that refinancing still makes sense financially after factoring in fees.

When you should wait to refinance a personal loan

Some personal loans may not be worth all the time and effort involved in refinancing. Here are some of the times when refinancing may not be the best move:

• Your loan balance is low: If you don’t owe much on your existing loan, it may not make sense to refinance since some lenders charge origination fees on top of the loan balance. Instead of incurring more fees, work on paying off the balance on your original loan more quickly.
• Your interest rate would be higher: If you’re not getting a more favorable interest rate by refinancing your loan, think carefully about proceeding. Refinancing at a higher rate only makes sense if you can’t afford the payments and need to extend your repayment term.
• Your loan term is almost finished: If you’re reaching the end of the loan term on your existing loan, refinancing may mean paying more money overall on interest.

How refinancing a personal loan affects your credit score

When you refinance, you’ll be subject to a credit check. This can lower your credit score slightly, but the drop should be temporary — especially if you practice good financial habits, like making on-time payments, with your new loan.

Keep in mind that a small hit could hurt if you’re also looking to buy a car or move into a new apartment. Car dealers and landlords check your credit score, and refinancing your loan at the wrong time could make it more difficult to find a vehicle or housing.

Advantages of refinancing a personal loan

While the advantages of refinancing your personal loan will depend on your goals, they generally include everything from getting a lower interest rate to reducing the overall cost of your loan.

• Better interest rate: If rates have dropped or you have improved your credit score, you could be able to save money on interest by refinancing at a lower average APR.
• Faster loan payoff: If you’re comfortable making higher monthly payments and you want to get out of debt faster, you can refinance a personal loan to a shorter term.
• Extended repayment period: Extending your loan repayment can help your payments feel more manageable. However, it usually means paying more in interest.
• Payment stability: Refinancing can provide payment stability if you’re switching from a variable rate to a fixed rate.
• Improved credit score: While the initial credit inquiry associated with refinancing may lower your score, making on-time payments on the new loan will increase your score over the long term.

Disadvantages of refinancing a personal loan

Refinancing is not the best option for everyone. Before committing to a refinance, consider the following drawbacks:

• Extra fees: Anytime you take out a new loan, you might have to pay additional lender fees, which can cut into the money-saving benefits you may be trying to achieve.
• Prepayment penalties: Some loans come with a prepayment penalty. Check the terms of your current loan to determine whether you’ll be penalized for paying it off early.
• Potentially higher interest costs: Extending a loan term usually results in more interest costs over time. If you’re trying to lower your monthly payment because of financial difficulties, you might still consider refinancing.
• Credit score impacts: Because refinancing counts as a new loan inquiry, it can lower your credit score, even if the impact is minimal and temporary.
• Research and application time: It takes time to research lenders, compare quotes and send in applications. If your loan is close to being paid off, refinancing may not be worth the hassle.

The bottom line

Before you refinance a personal loan, make sure that you will actually be saving money — ideally through a lower interest rate. And remember that a lower monthly payment over a longer term will ultimately cost you more over the life of the loan.

Additional fees associated with the new loan, as well as prepayment penalties for your current loan, can also make refinancing a costly switch. Be sure to review all expenses associated with the refinancing process carefully before making a decision to proceed.